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The Fed is done - Axel Merk

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(Kitco News) - The biggest bank failures in the U.S. since the 2008 Great Financial Crisis have revealed just how fragile financial markets are as the world comes to grips with years of cheap money abruptly halted by the Federal Reserve's aggressive monetary policy stance.

In an interview with Kitco News, Axel Merk, president and chief investment officer of Merk Investments, said that there is no question that gold prices are going higher in this environment. He noted that while the Federal Reserve may raise interest rates by 25 basis points at next week's meet, this tightening cycle has effectively ended.

"They may do one more rate hike to save some face, but the Fed is done," he said. "The ultimate mandate of the Federal Reserve is not inflation and not employment, it's financial stability. The cracks in financial stability are getting wider, so yes, they are done. They can't continue to hike interest rates when the world is on fire."

Merk added that even if there is no new contagion from the failure of Silicon Valley Bank and Signature Bank, the Federal Reserve can't afford to continue down its aggressive path. He added that while the broader financial market might be resilient for now, other threats are looming on the horizon.

"When the Federal Reserve is higher for longer, stuff is going to break; it's just a matter of when and where. Stuff is going to break, and everything else is just details," he said.

In this environment, Merk said it is logical to expect gold prices to continue higher. The Federal Reserve is done raising rates and markets pricing in a potential rate cut in June; at the same time, inflation remains significantly elevated. Merk said this scenario will lead to lower real rates, making gold an attractive non-yielding, safe-haven asset.

Along with the Federal Reserve ending its aggressive rate hikes, Merk noted that the world has entered a new quantitative easing cycle as the government now looks to protect all bank deposits.

While the government has been hesitant to call this new guarantee a bailout, Merk said that is precisely what it is. He added that there is not enough money in the system if the problem exacerbates.

"A week ago, we had over $600 billion in unrealized losses versus the FDIC's fund of about $120 billion. There remains this disconnect in the system. This is only a half-baked solution. Deposit insurance is not unlimited."

Merk added that the government guarantee of all deposits could be one of the reasons why the banking crisis is now spilling into the European system. Investors and consumers continue to move their money out of banks and into higher-yielding assets. This week, the U.S. government has given consumers another reason to move their money, draining more liquidity from the system.

"Not everyone is going to move their money, but it will have an impact on the margins and in this business, it's the margins that matter," he said.

Merk's comments come as one of Europe's top banks, Credit Suisse, saw its share price plummet Wednesday. The selloff came a day after the Swiss bank said in its annual report that it lost roughly $8 billion last year. Late last year, Credit Suisse said it saw "significantly higher cash withdrawals and net asset outflows in the third quarter of 2022.

Wednesday, shares of Credit Suisse — a Swiss bank with extensive U.S. and global operations — tumbled 31% before paring back declines to 20%. This was the biggest one-day selloff on record.

Gold will outshine the other precious metals as fears of a global banking crisis grow - Mitsubishi's Jonathan Butler

As to how bad this new banking crisis could get, Merk said that is something everyone will have to wait to find out. He added that the lack of mark-to-market accounting regulations have revealed a significant flaw in the system.

He explained that banks have been allowed to have unhedged exposure to fixed-income products. While yields on long-term bonds have risen in the past year, the price institutions paid for their bonds has dropped.

With investors moving their low-yielding bank deposits into bonds, banks are forced to sell their treasuries at a loss to make sure they have enough cash on hand to meet their customer's withdrawal requests.

"The core of the problem, it's what caused the financial crisis, it's what the caused SVB crisis, is that banks are not marking their securities to market. To think that you can hold assets to maturity and you don't have to worry about losses is suicidal," he said.

Merk noted that this could be the start of a much bigger trend as the recent bank failures have forced other regional banks to reevaluate their assets, which could cause them to take losses, creating a domino effect in financial market.

"Once again, we're completely relying on the bureaucrats to keep us safe. What can possibly go wrong," he said.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.